TOPIC 8

REPORTING AND INTERPRETING

LIABILITIES
PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
UNDERSTANDING THE BUSINESS

The acquisition of assets is

financed from two sources:

Debt Equity
Funds from Funds from
creditors owners
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UNDERSTANDING THE BUSINESS

Debt is considered riskier than equity.

Interest is Creditors
a legal can force
obligation. bankruptcy.

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LIABILITIES DEFINED AND CLASSIFIED

Defined as probable debts or obligations of the

entity that result from past transactions, which will
be paid with assets or services.

Maturity = 1 year or less Maturity > 1 year

Current Noncurrent
Liabilities Liabilities

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LIABILITIES DEFINED AND CLASSIFIED

Liabilities are
recorded at their
current cash
equivalent, which is
the cash amount a
creditor would accept
to settle the liability
immediately.

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 CURRENT LIABILITIES

Account Also
Name Called Definition
Trade Obligations to pay for goods and
Accounts
Accounts services used in the basic operating
Payable
Payable activities of the business.
Obligations related to expenses that
Accrued Accrued have been incurred but have not been
Liabilities Expenses paid at the end of the accounting
period.
Notes Obligations due supported by a formal
N/A
Payable written contract.
Obligations arising when cash is
Deferred Unearned
received prior to the related revenue
Revenues Revenues
being earned.

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 PAYROLL TAXES

Gross Pay

Net Pay
Less Deductions:

Social Medicare Federal PensionTaxes Voluntary

Security Tax Income Tax Deductions
Tax
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 NOTES PAYABLE

A note payable specifies an annual interest

rate associated with the borrowing.
To the lender, interest is a revenue.
To the borrower, interest is an expense.

Interest = Principal × Interest Rate × Time

When computing interest for one year, “Time”

equals 1. When the computation period is less
than one year, then “Time” is a fraction.
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 NOTES PAYABLE

Starbucks borrows
$100,000 for 2 months at
an annual interest rate
of 12%. Compute the
interest on the note for
the loan period.

Interest = Principal × Interest Rate × Time

2
Interest = $ 100,000 × 12% × / 12
Interest = $ 2,000

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 DEFERRED REVENUES

Revenues that have been collected but not

earned.

Deferred revenues are reported as a liability because cash has

been collected but the related revenue has not been earned by
the end of the accounting period.

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 ESTIMATED LIABILITIES

Contingent liabilities are potential liabilities that are

created as a result of a past event.

Probable Reasonably Possible Remote

Subject to estimate Record as liability Disclose in note Disclosure not required
Not subject to estimate Disclose in note Disclose in note Disclosure not required

The probabilities of occurrence are defined in the following manner:

1. Probable—the chance that the future event or events will
occur is high.
2. Reasonably possible—the chance that the future event or
events will occur is more than remote but less than likely.
3. Remote—the chance that the future event or events will
occur is slight.
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INTERNATIONAL PERSPECTIVE—IFRS
IT’S A MATTER OF DEGREE

The assessment of future probabilities is inherently subjective

but both US GAAP and IFRS provide some guidance.

Under GAAP, “probable” In the case of IFRS,

has been defined as likely probable is defined as more
which is interpreted as likely than not which would
having a greater than 70% imply more than a 50%
chance of occurring. chance of occurring.

This difference means that companies reporting under IFRS

would record a liability when other companies reporting under
GAAP would report the same event as a contingency. 9-12
 LONG-TERM LIABILITIES

Maturity = 1 year or less Maturity > 1 year

Current Noncurrent
Liabilities Liabilities

Creditors often require the borrower to

pledge specific assets as security for
long-term liabilities.

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LONG-TERM NOTES PAYABLE AND
BONDS
Relatively small debt
needs can be filled from
single sources.

Banks Insurance Pension

Companies Plans
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LONG-TERM NOTES PAYABLE AND
BONDS
Significant debt needs are
often filled by issuing
bonds to the public.

Bonds Cash

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INTERNATIONAL PERSPECTIVE
BORROWING IN FOREIGN CURRENCIES

Companies may elect to borrow in foreign markets

•To lessen exchange rate risk.
•Because interest rates often are low in other countries.

For reporting purposes, accountants must convert, or translate, foreign debt

into U.S. dollars.

Assume that Starbucks borrowed 1 million pounds (£). For the Starbucks
annual report, the accountant must use the conversion rate as of the balance
sheet date, which we assume was £1.00 to $1.50.

£1,000,000 × $1.50 = $1,500,000

Starbucks would report the debt at $1,500,000 on their financial statements.

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 PRESENT VALUE CONCEPTS

$1,000 In 1 year it In 5 years it

invested will be worth will be worth
today at 10%. $1,100. $1,610!

Money can grow over time because it

can earn interest.
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 PRESENT VALUE CONCEPTS

The growth is a mathematical function

of four variables:
1. The value today (present value).
2. The value in the future (future
value).
3. The interest rate.
4. The time period.

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PRESENT VALUE OF A SINGLE AMOUNT

The present value of a single amount is

the worth to you today of receiving that
amount some time in the future.
Present Future
Value Value
Interest compounding periods

Today Future

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PRESENT VALUE OF A SINGLE AMOUNT

How much do we need to invest today at 10%

interest, compounded annually, if we need $1,331
in three years?
a. $1,000.00
b. $ 990.00 The required future amount is $1,331.
c. $ 751.30 i = 10% & n = 3 years
Using the present value of a single
d. $ 970.00 amount table, the factor is 0.7513.
$1,331 × 0.7513 = $1,000 (rounded)

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 ACCOUNTING APPLICATIONS OF
PRESENT VALUES
On January 1, 2014, Starbucks bought some new
delivery trucks. The company signed a note
agreeing to pay $200,000 on December 31, 2015.
The market interest rate for this note is 12%.

Future value $ 200,000

PV of $1
(i=12%, n=2) × 0.79720
Present value $ 159,440

Let’s prepare the journal entry to record the purchase.

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 ACCOUNTING APPLICATIONS OF
PRESENT VALUES
GENERAL JOURNAL
Date Description Debit Credit
Jan. 1 Delivery trucks 159,440
Notes payable 159,440

Present Value × Interest Rate = Interest

$159,440 × 12% = $19,133

December 31, 2014

GENERAL JOURNAL
Date Description Debit Credit
Dec. 31 Interest expense 19,133
Notes payable 19,133
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 ACCOUNTING APPLICATIONS OF
PRESENT VALUES
Now, let’s look at the journal entries at
December 31, 2015.
GENERAL JOURNAL
Date Description Debit Credit
Dec. 31 Interest expense 21,429
Notes payable 21,429

31 Notes payable 200,000

Cash 200,000

Present Value × Interest Rate = Interest

($159,440 + $19,133) × 12% = $21,429
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 DEFERRED TAXES

Exist because of timing differences

caused by reporting revenues and
expenses according to GAAP on a
Deferred Taxes company’s income statement and
according to the Internal Revenue
Code on the tax return.

Timing differences that cause

Temporary deferred income taxes and will
Differences reverse, or turn around, in the
future.

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